DISCUSSION

This resolution authorizes an increase of $2,569,390, or 198%, in revenue for an 8.77% return on rate base for test year 2006, as authorized in D.05-12-043 for Southern California Edison's electric and gas operations. As shown in Appendix D, for an average customer with a 5/8 x 3/4-inch meter who consumes 3640 gallons per month, the summer monthly bill will increase from $30.79 to $55.94, or an increase of 82%, in 2007. The same customer's winter bill will increase from $25.28 to $49.75, or an increase of 97%, in 2007.

To mitigate the impact of the large rate increase, the increase will be phased-in over four years from 2007 to 2010. Catalina Island is also authorized to establish a Deferred Revenue Requirement Tracking Account (DRRTA) to track the annual deferred revenue that results from the rate increase phase-in plan.

The Division performed an independent analysis of Catalina Island's summary of earnings for the years 2006 to 2008. Appendix A shows Catalina Island and the Division's estimates of the Summary of Earnings for Test Year 2006 and for escalation years 2007 and 2008.

Audit of Expenses

To ensure proper accounting of the expenses and the rate base used to justify the rate increase, the Division conducted an audit of Catalina Island's records. As a result of the audit, some reported expenses were either restated or excluded entirely. Catalina Island disputed several of the Division's audit findings. After further review, the Division finds either partial or complete merit in Catalina Island's explanations for the following three items:

1) Expenses related to Asplundh Tree and Abate-a-Weed concerning vegetation removal from dam faces and surrounding areas (the work was performed at the request of the California Department of Water Resources, Division of Safety of Dams);

2) Housing allowance for the general manager and the water superintendent (this is consistent with D.83-10-043 in the 1983 GRC in which a travel allowance for Southern California Edison's employees was deemed reasonable and was allowed as a rate-making expense); and

3) $27,583 in marketing for conservation expenses.

The Division has allowed the company to place into rates the full cost for items 1 and 2, but only one-half of the cost of item 3. The reason for excluding half the cost of item 3 is that the Division finds merit in the auditor's conclusion that these expenses were not purely conservation-related educational items, but were in part cost for promotional items that benefited Southern California Edison's public image and goodwill.

Uniform System of Accounts

The Division's audit determined that Catalina Island's accounting system for operation and maintenance expenses did not follow the Uniform System of Accounts (USOA) format as required by the Commission for Class B, C, and D water utilities. Instead, Southern California Edison followed the FERC accounting format appropriate for its electric and gas operations. At the request of the Division, the expenses were restated by Southern California Edison to comply with the USOA standard. The Division recommends that Southern California Edison be required to follow the USOA format in Catalina Island's accounting system.

Capital Improvement Projects in 2005 and 2006

Central to this general rate case are the following ten capital projects totaling $6,838,965:

1. Little Harbor Pipeline Replacement - to improve the reliability of the water distribution system by replacing severely damaged and vulnerable sections of the primary service pipeline to customers on the west-end of Catalina Island. Total cost was $784,008;

2. Middle Ranch Well 6-A Installation - involves the construction of a new drinking water well and associated electrical operation and control system, due to surface water contamination of an old well. Total cost was $1,119,108;

3. Middle Canyon and Cape Canyon Piezometer Installation - involves the installation of six piezometers for subsurface water table information-gathering purposes. Total cost was $332,175;

4. Thompson Piezometer Pier Decommissioning - involves the removal of the Thompson Reservoir pier and the proper abandonment of the associated piezometers. Total cost is $100,000;

5. Pebble Beach Landfill Distribution Pipeline - involves the design and construction of a new potable water service pipeline to provide drinking water service to the customers at the east-end of Catalina Island. Total cost was $385,672;

6. Wrigley Reservoir - involves the design and replacement of the reservoir cover, reservoir liner, area draining, and a bypass pipeline system at Wrigley Reservoir. Total cost was $2,503,934;

7. Desalination Plant Source Water and Drainage System - involves the design and construction of two new seawater source wells, an underground water transmission pipeline, and some subsequent desalination plant improvements. Estimated cost of the project is $1.016 million, but estimated net cost to Catalina Island ratepayers is $266,000 due to a $750,000 settlement that Southern California Edison received to offset the total cost;

8. Howlands Distribution Tank - involves the replacement of the Howlands water distribution tank. Total cost was $456,699;

9. Lead and Copper Aeration System - involves the design and construction of an 800-gpm water treatment aeration system to reduce copper and lead levels at customer faucets. Total cost was $1,160,368; and

10. Basement Fill (Common Project) - involves the filling of the basement of the combined administration office with concrete. Total cost was $97,000.

The Division examined workpapers and expenses on the ten projects. The Division staff further visited the ten sites involved in the projects. The Division agrees with Catalina Island on both the need for the capital projects and their levels of expenditure.

Expenses

With the exception of a few accounts in which 2004 figures were not representative of historical norms, the Division estimated the expenses for Test Year 2006 by using the actual 2004 expenses as the starting point, adjusting the expenses by the audit recommendations. For the several accounts where 2004 did not appear to represent historical norms, due apparently to the one-time expenses associated with the start-up of the desalination plant, 2005 historical amounts or 2006 Southern California Edison-requested amounts were selected. The Division then escalated the expenses using the appropriate labor or non-labor inflation factors to bring all the expenses to the 2006 level. The Division then added in the following expenses that Catalina Island budgeted as additional expenses for 2006 and beyond:

1. $15,000 in non-labor cost for production, justified by lead and copper sampling costs;

2. $14,000 in labor cost for distribution, justified by 2 new utility positions;

3. $72,000 in non-labor cost for distribution, justified by 2 new utility positions and new activities (dam maintenance, water tank inspection and cleaning, meter accuracy);

4. $43,000 in labor cost for production, justified by 2 new utility positions;

5. $9,000 in non-labor cost for production, justified by 2 new utility positions;

6. $147,000 in labor cost for office supplies and expenses, justified by 3 new positions (water superintendent, engineer, project analyst) in 2006, removal of one part-time position, training of 7 crew members to obtain Department of Health Services (DHS)-required certification;

7. $68,000 in non-labor cost for office supplies and expenses, justified by the housing allowance for the 3 new positions, minus one part-time position, training of 7 crew members for DHS-required certification, and regulatory filing expense; and

8. 1% Franchise Fee rate to be paid to the City of Avalon and a 0.24% uncollectibles rate.

The Division largely selected 2004 as the appropriate base year for escalation for the following reasons:

1. By the end of 2004, Catalina Island had completed the reactivation of the desalination plant and any extra costs associated with the normal operation of the desalination plant were reflected in the 2004 reported expenses; and

2. 2005 and 2006 are inappropriate years for escalation as they likely contain significant one-time costs associated with major capital improvement activities which were begun in 2005 and completed in 2006.

Expenses for years 2007 and 2008 were estimated by escalating the 2006 Division-recommended expenses in the same manner to bring them to the respective 2007 and 2008 levels. The Division then calculated the revenue requirements necessary to produce the authorized rate of return of 8.77% on rate base for 2006 to 2008.

Desalinated Water

Producing fresh water from sea water by desalination is a highly energy intensive process and should be utilized only when no other economical water supplies are available. This is illustrated by the fact that for Catalina Island in 2005 desalinated water accounted for only 25% of total water production, but desalination accounted for approximately 70% of total electricity usage. As 2005 was a wet year, with rainfall at 145% of the historical norm, there is no convincing evidence that desalinated water was needed as a significant supplemental supply source in 2005, save perhaps for a small amount necessary to keep the plant running at a certain state of operational readiness and to allow the crew members to keep their certification. This point aside, the Division did not reduce the amount of projected purchased power expense based on this observation.

Purchased Power Expense

The Division's calculation of the purchased power expense for 2006 to 2008 is based on the three-year (2003 - 2005) average power factor (kWh/1000 gallons) of net production data. The average power factor is then multiplied by the projected water production to calculate projected power consumption. Finally, the projected power consumption is multiplied by the 2005 composite power cost ($/kWh) to arrive at the purchased power cost. Using this method, the Division's estimate for electric costs is less than that estimated by Southern California Edison by a fair amount as Appendix A shows.

In accordance with Res. No. W-4467, dated April 22, 2004, Southern California Edison is authorized to establish a memorandum account to track changes in purchased power expenses. Recovery of the expenses may be requested by advice letter at any time or may be considered for recovery in Catalina Island's next general rate case.

Phase-in Plan

To alleviate the impact of the large increase, Southern California Edison proposed a 3-year phase-in plan, with revenues to be partially deferred from collection in 2006 and 2007. In the phase-in plan originally proposed by Southern California Edison, there will be no deferred revenue for year 2008 and all deferred 2006 and 2007 revenues will be fully paid up by the end of 2008 as well. The Division instead recommends a phase-in plan such that required revenue increases follow a 3-year phase-in and deferred revenue collection follows a 4-year phase-in. Under this hybrid plan, the annual required revenue portion will be fully phased in by 2009. Furthermore, the deferred revenue requirement for year 2007 will be amortized over the years 2008 to 2010 in level amounts. Likewise, the deferred revenue requirement for 2008 will be amortized over years 2009 and 2010 in level amounts. The revenue phase-in plan is shown in Appendix B. The 2009 and 2010 revenue requirements shown in Appendix B have been projected for illustration purposes and do not include provisions for inflation and additional plant investments. The Division recommends that Southern California Edison be authorized to file advice letters in 2009 and 2010 to increase rates to reflect inflation in 2008 and 2009 and any additional plant improvements.

Southern California Edison requested permission to create an interest-bearing Deferred Revenue Requirement Tracking Account (DRRTA) to track the deferred revenue arising from the phase-in plan. Southern California Edison further requested that the prevailing 90-day commercial paper rate, compounded monthly at 1/12th the published rate, be used to track the deferred revenues.

The Division considered Southern California Edison's proposal for the DRRTA and concurs with Southern California Edison concerning the need for this deferred revenue tracking mechanism. However, as minimizing rate shock is a well-founded Commission rate-making principle, the Division recommends that deferred amounts arising from test years 2007 and 2008 be non-interest bearing. Furthermore, Res. No. W-4540 would ordinarily allow all Class B, C, and D utilities a surcharge for uncollected revenue for the period between the first day of the test year (2006) and the effective date of the rate increase. In this instance, in order to minimize the impact of rate shock, the Division recommends that no such surcharge be allowed, since Southern California Edison elected to forego an interim rate increase as stated in the cover letter of its advice letter for this general rate case.

The Division recommends this hybrid 3-year/4-year phase-in plan as it creates gentler rate increases over a four-year period than either a purely 3-year or purely 4-year phase-in plan can. In order to prevent application of retroactive ratemaking, the Division also recommends that Southern California Edison be barred from deferred revenue collection for all of 2006 and that part of 2007 prior to the effective date of this resolution. The DRRTA will therefore only track deferred revenue starting with the effective date of this resolution. The details of the hybrid 3-year/4-year phase-in plan are shown in Appendix B.

Service Charge

As a water utility with no purchased water expenses, Catalina Island has high fixed costs amounting to approximately 80% of required revenues. Catalina Island's current rate structure is such that it collected only 21% of the fixed costs through its service charge in 2005, whereas the Division's Standard Practice U-7-W, (Rate Design for Water and Sewer System Utilities Including Master Metered Facilities) recommends that a Class C water utility should recover up to 65% of the fixed costs through its service charge. To change Catalina Island's rate structure to approach the 65% fixed cost recovery rate would create significant hardship on its low-usage water customers. The Division therefore retained the rate structure such that 21% of the fixed costs are recovered in the service charge. A side benefit of this lower than recommended fixed cost recovery rate than that recommended in Standard Practice U-7-W is that more of the revenue is recovered through the quantity charge, creating an added incentive for customers to conserve water.

Furthermore, Standard Practice U-7-W recommends that the service charge for each meter size should follow a set of progressive ratios based on meter size. It soon became apparent that with Catalina Island's current rate structure, forcing adherence with the progressive ratios would lead to violation of the principal that no customer would receive more than twice the average increase for the whole system. The ratios were therefore relaxed to create a flatter service charge scale, with the service charge rate increase for the larger meter sizes set at twice the rate increase for the smaller meter sizes. It is expected that with each successive rate increase, the service charge rates will approach those implied by the ratios in Standard Practice U-7-W.

Quantity Rate

The Division largely relied on Catalina Island's projection of usage patterns for 2006 to 2008 by season and tier. The Division retained the conservation factor format proposed by Southern California Edison to create a 3-tier increasing block rate structure. Furthermore, summer and winter quantity rates were separately calculated so that the average summer price is 116% of the total average price and the winter price is 82% of the average price, generally retaining the same methodology as presented by Southern California Edison in its filing workpapers.

Safe Annual Yield Study

Catalina Island's current safe annual yield of 515 acre-feet from its aquifers was established in D.90-05-033, dated May 4, 1990. Southern California Edison believes this figure to be still valid. The Division recommends that Southern California Edison be ordered to update the safe annual yield and file an advice letter within 180 days from the effective date of this resolution for the Division's review. The Division bases its recommendation on the variance and uncertainty of Southern California Edison's production figures submitted to the Commission and the fact that the last study was performed prior to 1990. The Division will recommend whether a revision of Catalina Island's safe annual yield is warranted.

Rate of Return on Rate Base

Consistent with Decision D.83-10-045 in the last general rate case, the appropriate rate of return on rate base is that which applies to Southern California Edison as a whole company and not just to its investments in water operations. Catalina Island should therefore be treated as a Class A water utility for the purpose of choosing the appropriate rate of return on rate base. By extension of this reasoning, the alternate method of determining the revenue requirement using the operating ratio method for Class C and D water utilities per D.92-03-093 does not apply. By

D.05-12-043, Southern California Edison's authorized rate of return on rate base for test year 2006 is 8.77%. The Division's calculations assume the 8.77% rate of return to be applicable for escalation years 2007 and 2008 as well.

Low-Income Assistance Program

The Commission, through its Water Action Plan, encourages water utilities to develop low-income rate assistance programs for water customers. As the Commission has no universal requirement currently in effect to compel a water utility to offer any type of low-income assistance program, its implementation is considered on a case-by-case basis at each water company's general rate case.

The Division requested Southern California Edison to explore the cost effectiveness and feasibility of implementing a CARE-type program (California Alternative Rate for Energy available for energy customers) to provide low income residential customers with a 20% discount on their water bills. Southern California Edison considered the costs and benefits of implementing this program during the current GRC cycle. Southern California Edison estimated that the implementation cost relating to system and billing modifications would total approximately $70,000, while the total estimated discount to all low income customers during the first test year would amount to under $19,000. Southern California Edison further cited "other more massive system conversions and changes for implementation of the Enterprise Resource Planning (ERP) system are currently in progress" as impediments to the implementation of a low-income program during the current GRC cycle.

Although the Division is mindful to always take into account the costs versus benefits when considering a low-income assistance program, the Division concludes Southern California Edison's justification to postpone the program to the next GRC cycle based on its comparison of costs versus benefits to be fallacious. First, the $70,000 implementation cost estimate cited by Southern California Edison seems grossly excessive. Second, even assuming the $70,000 implementation cost estimate to be accurate, it is still predominantly a one-time expense. Whether the low-income program is implemented during the current GRC cycle or the next, roughly the same $70,000 expense would still have to be incurred.

The Division is also not persuaded by Southern California Edison's explanation of ongoing system conversions being impediments to a timely implementation of a low-income program. While the system conversions may present a temporary challenge to implementation, the Division expects the conversions to conclude far in advance of the next expected GRC cycle in 2009. It defies common sense to postpone the low-income program to 2009 based on a short-term delay due to the system conversions.

The Division recommends that Southern California Edison be ordered to file an advice letter within six months of the effective date of this resolution to establish a low-income assistance program that offers a 20% discount to its low-income customers. The eligibility criteria will be modeled after the CARE program on Southern California Edison's electric and gas side.

Lastly, Southern California Edison estimates that approximately 10% of its customers would qualify for low income assistance. In order to simplify the implementation of the low-income assistance program, Division recommends that Southern California Edison be authorized to establish a memorandum account to track lost revenues arising from the 20% discount. Southern California Edison is authorized to then file an advice letter to recover the lost revenues by imposing a surcharge on its regular customers.

Conservation

Through its Water Action Plan the Commission also encourages conservation. Catalina Island's customer usage profile shows that 90% of customers use 33% of the water and the remaining 10% of customers consume 67% of the water. To promote water conservation given this usage profile, Southern California Edison proposes changing its current 2-tier increasing block rate to a 3-tier increasing block rate structure, with the third tier at a significantly higher rate than the first 2 tiers. The intent is to send a strong monetary signal to its largest water users to conserve water. The summer/winter differential rate structure will also be retained to encourage customers to conserve during the summer months when the system strains to provide an adequate water supply.